While the work of many licensed insolvency practitioners tends to focus upon insolvent situations, the provisions of the Insolvency Act 1986 mean that where company assets exceed £25,000, a formal solvent liquidation process is required if shareholders wish to close a company and withdraw the assets, normally cash, while benefitting from the capital gains tax regime.
Without a formal liquidation process, monies paid from a company to shareholders are by way of dividend which are taxed at income tax rates: the highest one being 45% (46% if you are taxed in Scotland ).
Thus, if one can benefit from the maximum capital gains tax rate of 20%, or even the Entrepreneurs’ Rate of 10% should special circumstances apply, the benefits of liquidation are clear.
There have been a large number of solvent liquidations of personal service companies “PSC” in the last four or five years for example when individuals working in the oil and gas industry have left the area and no longer have a reason to maintain a limited liability company, or there is no particular benefit in having a company because a staff position has been obtained.
The proliferation of PSCs in the north-east has resulted in many PSC shareholders receiving a substantial tax benefit when the monies are withdrawn from the company at closure.
The rules for obtaining capital gains tax relief tightened on April 6 because it was deemed somewhat unfair that a person could invoice through a PSC for several years, build up a large amount of cash in a tax-friendly company environment, and then liquidate the company with a 10% tax charge on the monies withdrawn. This has been seen as far more tax-advantageous compared with earning the same amount and paying a higher rate of income tax.
HMRC has sought to make it harder to act in this manner by, for example, changing the period of share ownership and disallowing capital gains tax treatment if the individual returns to the same industry in certain circumstances: designed to ensure that income tax applies rather than capital gains tax.
The tax landscape is changing again on April 6 2020, because HMRC proposes that PSCs operating in the private sector (not just oil and gas) are treated in the same way as those which have been operating in the public sector since April 2017 where income tax and national insurance has been deducted at source from every payment to a PSC if the receiver of the service considers that the basis of engagement is broadly similar to that of an employee. The current HMRC consultation period expired at the end of May and further pronouncements are expected shortly.
Anecdotal comment suggests the large oil and gas companies might operate a consistent interpretation of the tax treatment of a PSC, for example.
If one considers issues such as control, right of substitution and mutuality of obligation, one must ask who really decides what work is undertaken, when, and under whose control.
The views in this article are those of Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen. They do not purport to represent those of the firm in general.